The AI land grab just hit a wall
In my video insight ‘How General Purpose Technology booms end”, last month, I spoke about the five stages of a GPT boom and the inevitable, sometimes violent, way they end. I suggested that while the latest GPT – Artificial Intelligence (AI) – is undoubtedly life-altering and ultimately structural, the commercial path to its adoption is governed by cyclicality and the cost of capital.
After a period of hype-fuelled price appreciation, the inherent hopes that the new tech will grow, scale, and be adopted without disappointment, interruption, or speed bumps are usually met with a commercial reality that leads to disappointment.
This month, the first of what I suspect will be a series of cracks in the ‘structural’ thesis is appearing, and that crack is Oracle.
The US$10 billion “Hiccup”
The news this month is an example of the “cyclical business reality” I cautioned would eventually meet up with the structural thematic hype. Oracle’s longtime partner, Blue Owl Capital, has reportedly opted to eschew providing equity for a massive US$10 billion data centre project designed to power OpenAI’s future workloads. While Oracle was quick to dismiss this as a mere swap of partners – suggesting Blackstone or others may step in – investors are doing the Wall Street Walk – selling first and asking questions later.
Oracle’s shares tumbled five per cent overnight and are down 45 per cent since their September highs. More tellingly, the cost of protecting Oracle’s debt against default (Credit Default Swaps) surged to its highest level since the Global Financial Crisis (GFC) of 2009.
Why does a single financing “hiccup” in a Michigan township matter so much? Because it is the first tangible sign that the cost of capital is rising. That will limit the speed of the win-at-all-cost land grab, and it will trigger a shift in the narrative that had hitherto seen investors believe this version of AI is going to immediately change the world.
From cheap hype to expensive reality
In November, I noted the hype surrounding a new General Purpose Technology (GPT) generally brings down the cost of investment, leading to a massive surge in capital expenditure (capex) to “scale” the opportunity. We have seen this “tick” in the box with Nvidia’s vertical share price and the billions poured into data centres.
But as I warned, “When a structural theme meets a cyclical commerciality, it’s the cyclical commerciality that wins.”
Blue Owl’s hesitation isn’t a doubt about AI’s potential; it’s a doubt about the lease terms and the debt load. Investors are beginning to realise that “unlimited total addressable market” is a phrase used by people who don’t have to pay back the loans. When the primary financier of your infrastructure starts asking for tougher terms, the “low cost of capital” era is officially over.
It’s a nail in the coffin of the boom, a bursting of the bubble.
Overcapacity
History is a relentless teacher. We saw this with the 1,000 American TV manufacturers that no longer exist, and the thousands of car companies that were eventually reduced to a handful of survivors. Their technology changed the world, but investors suffered through a period of Creative Destruction first. Creative Destruction is an economic concept that encapsulates the cycle of new innovations being consistently disrupted and replaced by even newer technology.
I believe we might be entering that phase now. The “insider faith” in which bubble participants prop up each other’s revenue is being challenged by a reality check: the timelines for AI profitability are simply inaccurate. As share prices drop and volatility rises, the debt accumulated at the end of the boom begins to cause companies to fail.
Nothing has changed (except everything)
Investors will soon cry out, “But nothing has changed! AI is still the future!” They will be right about the technology but wrong about the maths.
The theme remains true, but the price of admission has just gone up. Lower prices are required on entry to generate reasonable returns. That adjustment to entry prices is what might have just commenced.
If the government steps in – as Sam Altman has already hinted at with talk of “government backstops” – the early investors might be rescued. But if history is any guide, the technology will only truly change the course of human history after it has been secured by “distressed asset” buyers at a fraction of its current cost.
And that means we need lower prices first.
The Michigan “slip-up” is the first snowflake of a potential winter for AI investors who have hoped too hard and paid too much. The process of invention, hype, and overcapacity is now yielding to its next inevitable stage: Creative Destruction. It’s a painful process, but it is the only way to put this technology into every human’s hands at a price they can actually afford.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
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